The South Sea Bubble, Britain's great crash of 1720

The South Sea Bubble was the speculative frenzy that swept London in 1720 around the shares of the South Sea Company, a British company that had taken over most of the national debt in exchange for its own stock. The share went from £128 in January 1720 to about £1,000 in the summer and collapsed by September, ruining thousands of investors; by December it was down to £124. Parliament's inquiry in 1721 found fraud among the directors and bribes to ministers, and sent the Chancellor of the Exchequer to the Tower of London.

In 30 seconds

• The company was founded in 1711 to absorb government debt. Its promised trade with Spanish America barely materialized; what it did carry out was mainly the slave trade.
• In 1720 Parliament let it swap most of the national debt for shares. The higher the share price, the more the company earned, so it had every reason to talk the price up.
• It did: with rumors of fabulous profits, loans to buy its own shares and stock given to politicians. The price multiplied about eight times in seven months and then collapsed.
• The inquiry of 1721 found widespread fraud. The directors lost most of their fortunes, and the company survived, much reduced, until 1853.

Timeline

1. 1711

   The South Sea Company is founded to take over £9 million of government debt, with a monopoly on trade with Spanish America.

2. 1713

   The Treaty of Utrecht grants it the Asiento, the right to sell enslaved Africans to the Spanish colonies, and one trading ship a year.

3. 1718

   King George I becomes governor of the company.

4. Jan. 1720

   The company proposes to take over most of the national debt in exchange for its shares. The share trades at about £128.

5. Apr. 1720

   Parliament accepts the plan in a slightly altered form.

6. 11 Jun. 1720

   The Bubble Act bans joint-stock companies without a royal charter or an act of Parliament.

7. Jun.-Aug. 1720

   The peak: £1,050 in June according to the New York Fed's account, about £1,000 in early August according to Britannica.

8. Sep. 1720

   The collapse: the share falls to £175 (New York Fed) or £150 by the end of the month (other accounts). Banks and goldsmiths fail.

9. Dec. 1720

   The share is down to £124. Parliament is recalled and an inquiry begins.

10. 1721

    The inquiry reveals fraud by the directors and bribes to ministers. Aislabie is expelled from the Commons and imprisoned in the Tower. Robert Walpole takes charge.

11. 1853

    The South Sea Company, which had sold most of its trading rights to Spain in 1750, finally disappears.

What was the South Sea Company?

It was born in January 1711 as a public-private deal. An inquiry into the national debt had found that the government owed about £9 million with no income set aside to pay it. Robert Harley and John Blunt devised a solution: the holders of that debt would hand it over to a new company in exchange for shares of the same nominal value, and the government would pay the company an annual sum, equivalent to 6% interest plus expenses, which would be passed on to shareholders as dividends.

To make the shares more attractive, the company was given a monopoly on trade with South America, then controlled by Spain, with which Britain was at war. According to Britannica, the 1713 Treaty of Utrecht was less favorable than hoped: it granted the company the Asiento, the right to supply enslaved Africans to the Spanish colonies, and allowed only one ship a year for general trade. The promise of riches from the “South Seas” was, from the start, much larger than the business behind it. In 1718 King George I became the company's governor, which, as Britannica notes, created confidence in the enterprise.

How did the bubble of 1720 work?

In January 1720 the company proposed something far more ambitious: to take over most of Britain's remaining national debt, about £31 million, in exchange for new shares. It outbid the Bank of England, and Parliament accepted the plan in a slightly altered form in April 1720.

The key was in the conversion. Debt holders received shares at the market price, not at face value. The higher the share price, the fewer shares the company had to hand over for each pound of debt, and the more shares it had left to sell at a profit. In other words, the company's business was no longer trade: it was its own share price.

So it set about raising it. According to the account in Wikipedia's article, based on the standard histories of the episode, the company spread “the most extravagant rumours” about its trade in the New World; it lent people money to buy its own shares, secured on those same shares; and it “sold” shares to politicians, who didn't pay for them but could sell them back to the company at any time and pocket the increase. Lord Sunderland, the King's mistress and the Chancellor, John Aislabie, were among those who stood to gain from every pound the price rose.

The price obeyed. It went from £128 in January to £175 in February, £330 in March and £550 at the end of May. The euphoria spread to other companies, the so-called “bubbles”: one apocryphal story tells of a company that went public in 1720 “for carrying out an undertaking of great advantage, but nobody to know what it is.” On June 11, 1720, Parliament passed the Bubble Act, which banned joint-stock companies without a royal charter or an act of Parliament. Recent scholarship suggests it was passed to stop other companies from competing with the South Sea Company for investors' money.

When and why did it crash?

The sources agree on the shape and differ slightly on the numbers. According to the New York Fed's account, the share reached £1,050 in June and fell to £175 by September. According to Britannica, it rose “to more than 1,000 in August,” collapsed in September and was down to £124 by December. Wikipedia's article puts the peak at £1,000 in early August and the price at £150 by the end of September.

The cause of the fall was the same as that of the rise, in reverse. In August 1720 the first installments on the new shares came due, and many buyers who had bought on credit could only pay by selling. In Paris, John Law's Mississippi Company was collapsing at the same time, and money was being withdrawn across Europe. Once the price stopped rising, there was no business underneath to hold it up.

The losses spread. Banks and goldsmiths that had lent against South Sea stock couldn't collect their loans, and thousands of people were ruined, including many members of the upper class.

Did Isaac Newton really lose a fortune?

Yes, though the figures are smaller than legend sometimes suggests. According to the sources cited in Wikipedia's article on the company, Newton held nearly £22,000 in South Sea stock in 1722 and lost at least £10,000. The phrase most often attributed to him has a precise origin: the writer Joseph Spence recorded that Lord Radnor told him that when Newton was asked about the rise of South Sea stock, he answered “that he could not calculate the madness of people.” The more polished version, “I can calculate the movement of the stars, but not the madness of men,” is also attributed to him, but without such a clear source.

Who paid for the South Sea Bubble?

Parliament was recalled in December 1720 and opened an inquiry. Its report, in 1721, revealed widespread fraud among the company's directors and corruption in the government. According to Britannica, it showed that at least three ministers had accepted bribes and speculated. Among those implicated were Aislabie, the two James Craggs, father and son, and even the heads of the ministry, Lord Stanhope and Lord Sunderland.

Aislabie, who had negotiated the deal and steered it through the Commons, had been given £20,000 of company stock for promoting the scheme. He resigned in January 1721, and in March the Commons found him guilty of “the most notorious, dangerous and infamous corruption.” He was expelled from the House, removed from the Privy Council and imprisoned in the Tower of London.

The cleanup was led by Robert Walpole, the new First Lord of the Treasury, generally considered Britain's first prime minister. All 33 of the company's directors were removed and stripped of, on average, 82% of their wealth, and the money went to the victims. The company's stock was divided between the Bank of England and the East India Company. But Walpole also protected the King and saved several key officials from impeachment, by a margin of three votes. As Britannica puts it, he sacrificed only some of those involved to preserve the reputations of the government's leaders.

The company itself survived. It sold most of its trading rights to Spain in 1750 and lasted until 1853.

The MATERIUM lesson: how to recognize the same trap today

The South Sea Bubble fits two Laws of Deception: “Whoever is in the biggest hurry for you to buy is the one already selling” (that of Jordan Belfort), because the company and its friends earned more the higher the price went; and “If the lie is big and detailed enough, nobody checks it” (that of Gregor MacGregor, who sold bonds of an invented country in the same city a century later). And it adds one of its own: when the business is the share price, the share price is the only thing that will be defended.

Its lever was the purest form of fear of missing out: when everyone around you, from lords to shopkeepers, is getting rich, staying out feels like the risk. The same mechanism works today in hyped stocks pushed on social media and in cryptocurrency launches. The signs:

• The price is the product. If the only reason to buy is that the price is going up, you're not investing in a business: you're betting that someone will pay more after you. That's the logic of the pump-and-dump scheme.
• The promoter earns from the price, not from the business. Ask who profits when the price rises and whether they're selling while they encourage you to buy.
• Credit to buy more. When a platform lends you money to buy what it's selling you, a fall in price forces you to sell at the worst moment.
• Borrowed prestige. A king as governor in 1720; a celebrity or a politician today. Endorsement is not a guarantee.
• Everyone is talking about it. Euphoria isn't evidence. The more urgent the crowd, the more time you should take.

How to check it in the UK and the US. In the UK, look up any firm on the FCA Register and read the FCA's ScamSmart advice before investing; in the US, check the firm and the person on FINRA BrokerCheck and the SEC's Investor.gov. You'll find more signs in how to spot a scam and in our guide to investment fraud.

The South Sea Bubble opens our history of fraud and appears among the largest frauds by amount as one of the great cases before 1913. It doesn't have a MATERIUM episode yet; in the meantime, the full series is on the episodes page.